Wash Sales and IRAs

Harsh consequences when replacing stock in an IRA

The wash sale rule says you lose your deduction for stock sold at a
loss if you buy identical shares within 30 days before or after the
sale. Some people have suggested you can avoid the wash sale rule if you
sell shares at a loss in a regular brokerage account and, at the same
time, buy replacement shares in an IRA. The idea is that the IRA is a
distinct "person" for tax purposes, and the wash sale rule shouldn't
apply if the replacement shares are bought by a different person.

For many years we've said here that this idea doesn't work.
There's ample authority for the notion that a planned purchase
of replacement shares by a related person will prevent you from
deducting a loss. And the IRA is, of course, a related "person."
Yet some people persisted in recommending the transaction in the
absence of a direct authority applying this rule to an IRA. Now
the IRS has published a ruling (Rev. Rul. 2008-5) that lays down
the law: you lose your capital loss deduction if you use this
strategy.

The ruling specifies, in addition, that you do not obtain an
adjustment to the basis of your traditional or Roth IRA when the
rule applies. That means — as we've often warned here — the
result is worse than a normal wash sale, because the loss is
permanently disallowed rather than being added to the basis of
the replacement shares.

This rule will continue to be difficult for the IRS to
enforce. Purchases and sales occurring within an IRA are not
reported on Form 1099-B and will not show up in your individual
brokerage account statement. Yet the ugly consequence —
permanent disallowance of the deduction — may serve as a
deterrent even for people who might otherwise be inclined to
play the audit lottery.